Question

Read the following paragraphs to answer the question Why cartels like OPEC fail to reach to consensus on price and quantity?

When markets were collapsing as the coronavirus pandemic crushed demand in March and early April, the idea that crude could rise again to $40 a barrel was “a dream,” the energy minister of the United Arab Emirates, HHSuhail Al Mazrouei said during a conference call on Monday. That was before the OPEC+ alliance agreed unprecedented cuts in output.

Prices could return to “normal” within a year or two as curbs approaching 10 million barrels a day drain excess barrels from the market, Mazrouei said during the call hosted by the Atlantic Council, a Washington-based research institute.“We have seen very good signs of demand picking up,” Mazrouei said. “We have seen numbers of driving vehicles are picking up,” he said, citing demand growth in China, India and Europe.

Still, the direction of oil prices will hinge to a large extent on whether a second round of infections forces economies into lockdowns once again, he said.

Led by Saudi Arabia and Russia, the group aims to support a rally that’s seen Brent more than double to around $40 a barrel since late April, paring its loss this year to 40%. For that success to continue, all OPEC+ members must adhere to their production quotas, while other suppliers must refrain from resuming output too quickly, Mazrouei said.

“In previous deals we had countries cheat because there was no rule. Now there is a rule, so countries are coming and stating their commitments,” Mazrouei said. The OPEC+ agreement has effectively created a “permanent” group of nations -- one bigger than the Organization of Petroleum Exporting Countries -- that will coordinate to manage crude markets, he said.

Question: Why cartels like OPEC fail to reach to consensus on price and quantity?

Answer 1

Cartels like OPEC generally fail to reach a consensus on quantity. As a result, the price of the good also fluctuates. In a product like crude oil, extraction cannot be easily stopped once it is started. Further, countries always attempt to capture a larger share of the market, by pumping more and more oil. It is exactly this strategy that breaks down the cartel consensus.

---

Due to the Covid-19 global pandemic, demand for crude oil had crashed globally. This is because all major countries had imposed lockdowns, and people were not even leaving their homes.

When demand falls, and supply doesn't, the price of the good falls. This can only be corrected by cutting supply. This is what the OPEC decided to do.

Now when supply is cut, it creates another problem. As countries slowly start lifting lockdown measures, the demand begins to rise again. At this stage, oil producing countries are tempted to increase supply again gradually. This is because they would like to capture the rising demand in the market. In the current scenario, countries in Asia and Europe are increasing demand quite rapidly.

However, the oil producing countries are left in a state of confusion, because the pandemic has not ended yet. Due to this uncertainty, most OPEC members are not willing to cut output beyond a point. If they cut output amidst uncertain demand, it could affect their profits negatively.

---

Many OPEC members are already tempted to resume pumping more oil, and do not like these restrictions. Essentially, a cartel is as strong as the "agreement" is. If it is enforced by strong enough rules and penalties, the cartel will function. The basic instinct of profit maximizing behaviour is responsible for breaking down the agreements. It even leads many countries to leave the cartel altogether. Similar events may be seen in the oil producing nations, in the months to come.